Strengthening ELS Market Soundness and Liquidity Ratios... Limiting Excessive Issuance through Enhanced Leverage Regulations

Financial Services Commission Announces 'Measures to Stabilize the Derivative-Linked Securities Market'

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[Asia Economy Reporter Eunmo Koo] New soundness regulations will be introduced in the equity-linked securities (ELS) market, which has strengthened the soundness and liquidity management ratios of securities firms. Issuance will also be restricted through enhanced leverage ratio regulations to prevent systemic risks in the financial market.

On the 30th, the Financial Services Commission announced that it has prepared a "Derivatives-Linked Securities Market Soundness Plan" to proactively identify and respond to potential risk factors that derivatives-linked securities pose to securities companies, financial markets, and investors.

According to the soundness plan, securities firms will strengthen their internal risk management and enhance the regulation of liquidity ratios to be constantly prepared for increased market volatility.

First, as in March, securities firms will establish and review their own risk management systems to quickly respond to extreme market shocks. As the scale of ELS increases and market volatility expands, the impact on securities firms' liquidity and soundness grows, necessitating strengthened risk management capabilities to respond promptly when market shocks occur.

Specifically, recent extreme scenarios will be included in stress test scenarios, and the Financial Supervisory Service will inspect the results. Additionally, to prepare for increased volatility in global stock markets, securities firms will establish emergency foreign currency procurement plans related to their own ELS hedging.

Regulations on the won liquidity ratio will be strengthened for all securities firms issuing derivatives-linked securities to solidify the won liquidity ratio system. Since securities firms lack deposit functions, they raise large-scale funds through the short-term financial market to respond to margin calls from overseas derivatives exchanges. Currently, the won liquidity ratio (1-month and 3-month) is maintained at 100% or higher, but there are some shortcomings in calculating derivative-linked securities' liquid liabilities.

To address this, liquid liabilities will be calculated based on early redemption dates rather than final maturity, and the same won liquidity ratio regulations applied to comprehensive financial investment business operators will also be applied to general securities firms issuing derivatives-linked securities. The improvements will apply to new issuances after the regulation revision date.

To prevent ELS and similar products from causing systemic risks when shocks occur in the financial market, the scale of derivatives-linked securities will be reduced, and diversified investment in hedge assets will be encouraged. First, the larger the issuance amount of principal non-guaranteed derivatives-linked securities, the more the debt amount will be weighted in the leverage ratio to block excessive issuance incentives. From the portion where the balance of ELS and DLS (principal non-guaranteed) exceeds 50% of equity capital, the weighting will be gradually increased up to 200%. However, the weighting will be relaxed for ELS focused on domestic indices, which limit investor losses or have minimal impact on the foreign exchange market.

Furthermore, to alleviate currency mismatches between derivatives-linked securities' underlying assets and hedge assets, as well as concentration in corporate bonds, diversification regulations will be introduced to encourage diversified investment in hedge assets. To this end, a certain level of foreign currency liquid assets will be mandated for the scale of self-hedging of derivatives-linked securities based on overseas indices, and when bonds are included as hedge assets, corporate bonds will be limited to 10% of the hedge assets.

Finally, investor protection will be strengthened so that investors can fully understand the profit realization conditions and potential losses before making investment decisions. Derivatives-linked securities have limited redemption and low price transparency due to the absence of a secondary market. To improve this, authorities plan to build infrastructure that centralizes information on the derivatives-linked securities market on exchanges and provides investors with opportunities to sell before maturity.

Additionally, concerns about investor misunderstanding and incomplete sales related to the display of returns and subscription linkage on sales companies' websites and apps for ELS will be addressed to enhance investor risk warnings. Specifically, the "return when conditions are met" and "loss rate when conditions are not met" will be displayed closely with balanced font size, weight, and color, and access to the subscription menu will be allowed only after reading linked content such as "Check the simplified investment prospectus" or "See details," thereby increasing the objectivity of profit and loss information provision for ELS.

The financial authorities plan to immediately implement matters that can be pursued without regulatory amendments through industry guidance in August, while matters with significant market impact such as soundness and liquidity regulations will have flexible grace periods and implementation timings depending on market conditions, aiming to complete regulatory amendments within the year.

This content was produced with the assistance of AI translation services.